Sales Tax And The Internet Marketplace

The applicability of sales tax in Internet transactions is in the spotlight and one of the most contentious issues in the state tax arena. With states strapped for cash, some legislatures are focusing on a perceived subsidy that benefits Internet retailers to the detriment of "brick-and-mortar" retailers. Case and point, when you travel to the mall and buy the latest Harry Potter book, sales tax will be charged. However, order that same book via an Internet retailer, such as Amazon.com, and no sales tax is charged. So what gives?

Well, the taxation of out-of-state retailers (a/k/a remote sellers), including out-of-state Internet retailers, is governed by the U.S. Supreme Court's 1992 decision in Quill v. North Dakota, 504 U.S. 298 (1992). In Quill, the Supreme Court held that a state cannot require an out-of-state retailer, including an Internet retailer, to collect and remit sales tax unless the retailer has a "substantial nexus" with the state. A "substantial nexus," as a general matter, requires the retailer to have employees or offices in the state. Thus, the Quill standard thwarts the ability of states, in most cases, to mandate that Internet retailers collect and remit sales tax, due to the inability to establish a "substantial nexus."

Frustrated by the tens of millions in lost sales tax revenue and the competitive disadvantage faced by "brick-and-mortar" retailers, many states have enacted so-called "Amazon Laws" that stretch the meaning of "substantial nexus" in order to require Internet retailers to collect and remit sales tax. As the name implies, the "Amazon Laws" are aimed at Internet retailers such as Amazon.com. The "Amazon Laws" presume that a "substantial nexus" exists if an out-of-state Internet retailer is siphoned customers via web-links from the websites of in-state affiliates. In response to the "Amazon Laws," Amazon.com has severed its in-state affiliate relationships and is challenging the validity of the laws.

As you may have noticed, however, the discussion above does not mention an important point - the "use tax." When a person buys an item from an Internet retailer that does not collect and remit sales tax (e.g., Amazon.com), the purchaser is obligated to pay use tax. The use tax (a/k/a the "remote sales tax") mirrors the sales tax and applies in situations where the sales tax is inapplicable. If purchasers complied with use tax laws, the "Amazon Laws" would be moot. However, use tax compliance is sparse, spurring states on in the constant effort to impose sales tax on the Internet retailers.

If you have any questions regarding sales and use tax in general, or in the Internet context, please give me a call or shoot me an email.